Wall Street’s Role in the U.S. Mortgage Crisis Examined

August 20, 2008 at 6:30 PM EST

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As part of an ongoing series of conversations on recent U.S. economic woes, Paul Muolo co-author of "Chain of Blame: How Wall Street Caused The Mortgage and Credit Crisis" discusses his investiation into Wall Street's connection to the current housing and mortgage crisis.

MARGARET WARNER: A new book says Wall Street is responsible for setting off today’s economic woes. The book is called “Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis.” Its co-author is Paul Muolo, who has long covered the lending industry as executive editor of National Mortgage News.

Welcome, Paul.

PAUL MUOLO, Author: Thanks for having me.

MARGARET WARNER: So it wasn’t the lenders; it wasn’t the home-buyers. It’s Wall Street that’s at the root of all this? How so?

PAUL MUOLO: Well, they were the fuel guy on top. They had the big gasoline can of what we call “money,” lending to these non-bank subprime lenders who in turn lent to consumers.

Wall Street’s end game here was to more or less take over what we call the non-prime mortgage industry and take all these loans, create bonds, make fees all along the way, and sell these bonds to investors overseas and in the U.S.

If you take Wall Street out of the equation, this crisis is much, much smaller. They saw dollars in them thar hills. They saw gold, and they went after it.

MARGARET WARNER: And these loans were obviously risky?

PAUL MUOLO: Well, that’s a good question. I mean, they were believing that home prices would keep going up forever in hot markets like Orange County, California, Florida, take your pick. They believe they’d always be bailed out by home equity. And if something went bad, they’d just sell the house and be out.

MARGARET WARNER: But what you’re saying, it was really Wall Street and the availability of money, and their scheme — I don’t say that pejoratively — but to them turn them into bonds, essentially to resell them, that changed the traditional model of lending?

PAUL MUOLO: Right. Most Americans might look to that movie, “It’s a Wonderful Life,” Bailey Building and Loan, where go into their S&L, their bank, they get a loan, they hold the mortgage forever. The model…

MARGARET WARNER: So your local banker cares about whether you can pay it back?

PAUL MUOLO: Well, usually. One of the things that changed with Wall Street in this non-prime model, they thought they had built a better mousetrap where they used these independent loan brokers. They get table-funded through a non-bank lender, which Wall Street’s also financing.

Wall Street takes all the loans. They outsource the underwriting, the review of the documents, to a company like Clayton. And then, again, they package the loans into bonds. They have as little cost as possible. They don’t want full-time employees. They thought they had built a better mousetrap. That was their goal.

Bond market created instability

MARGARET WARNER: Now, in this whole -- you really describe a chain of commissions. I mean, people made money all around this cycle.

PAUL MUOLO: Indeed.

MARGARET WARNER: Describe how that worked.

PAUL MUOLO: Well, the independent loan brokers got a fee from the lender...

MARGARET WARNER: And give us an example of an independent loan broker.

PAUL MUOLO: Well, someone who is a freelancer, might work out of their house, or for a small loan brokerage company. He only or she only gets paid if they bring a loan to Countrywide and Countrywide closes that loan. They're not on the books of Countrywide. They're a freelancer.

And there's -- literally, there must have been 100,000, 200,000 of these independents out there. There's a lot less now. But, I mean, that was the structure. And it worked OK for many years on these A-paper, good credit quality loans.

But in the subprime, they got to charge extra points. No one was really policing them. And, again, Wall Street was fueling them through these wholesale lenders, like Ameriquest, Argent, Countrywide. And that's how the system worked.

And there weren't a whole lot of checks and balances. Everyone believed that the good times would last forever. And, you know, Wall Street didn't have much skin in the game here, because they'd package the loans, sell them off to someone else.

MARGARET WARNER: And you describe -- one great scene in the book is that Wall Street's -- these firms wanted the business to keep going so much so that they set up their own kind of bucket shops to approve the loans?

PAUL MUOLO: Right. One thing Wall Street did -- at first, they just funded the lenders. Then they wanted to own them themselves. And at the same time, they'd buy loans from other lenders and they'd own their own.

So they set up -- they used freelancers, the Clayton Group, the Bohan Group. They would set up these what we called them -- sort of Wall Street sweatshops in hotel rooms, where they jammed a bunch of people in there with laptops, and they review -- one loan an hour was the goal, we were told, by a lot of the people we talked to, the grunts with their laptops, and it was almost -- people, you know, standing on desks and yelling things, "Work faster, work faster," because it was like a factory.

They wanted to jam as much product through the system as possible, so they could get them to Wall Street, again, get those bonds created, sell those bonds, get those commissions, and be done with it.

Thirst for success blinded CEOs

MARGARET WARNER: Now, did the heads of the Wall Street firms that got -- that were involved in this -- pick Stan O'Neal at Merrill Lynch -- did they know how bad some of these underlying loans were?

PAUL MUOLO: Well, not initially. I mean, if they knew how bad they'd be, they'd be crazy to get in this business.

But, again, it came back to this belief that they were the smartest guys in the room and they knew what they were doing. They had this new mousetrap they had built and, again, that home prices would keep going up. And if something went bad, they'd be bailed out.

They jammed it all through computer systems, where they had what we call automatic underwriting or automated underwriting. The computer would, you know, spit out a credit report. And the guy's credit looks OK. Let's make that loan. No down payment. Don't worry about it. The house is going to keep going up. It's in California. You can't go wrong.

MARGARET WARNER: Speaking of California, one of the chief characters in your book -- though he's not on Wall Street -- was Angelo Mozilo, the head of Countrywide. Now, you've known him a long time. He said to you, at some point years ago, that, well, Wall Street will be our regulator. They'll sniff the bad stuff out.

So he knew there was bad stuff out there. How did he get so -- he and Countrywide get into this?

PAUL MUOLO: Well, Angelo is a phenomenal character in our book. And he's a guy who stayed in the A-paper, good credit business for 30 years. And he saw other companies like Roland Arnall's Ameriquest making a ton of money in subprime, and he couldn't resist the temptation, so he took Countrywide down that path and became almost a Trojan horse, subprime.

And he thought he can do it. He thought he could do it right. And his thirst to be number-one destroyed him, because subprime destroyed Countrywide, essentially. He wanted to be number-one. His ego got in the way, and Countrywide is no more, more or less. It's part of Bank of America now.

Easy money days are over

MARGARET WARNER: And Fannie Mae and Freddie Mac, the new worries about them on Wall Street this week.

PAUL MUOLO: Sure.

MARGARET WARNER: What was their role? Were they a driver in this?

PAUL MUOLO: Well, interestingly, Fannie and Freddie had their own accounting scandals before all this, back in '04 and '05. And they were flat on their backs. They were buying less and less loans. And they saw all their A-paper lenders get into subprime. And instead of selling those loans to them, they sold them to Wall Street, to Merrill Lynch, to Lehman Brothers, Bear Stearns.

So Fannie Mae and Freddie Mac, you know, they lost a lot of market share during these years. And when they started recovering, they wanted to get back in the game. They started buying the end bonds, the end subprime bonds, that had been -- bonds that had been created.

And they had what they believed was AAA insurance on those bonds, so if the subprime bonds went bad, they believed they would get paid off.

MARGARET WARNER: So, briefly, what's the upshot of all of this for the would-be home-buyer today who's going to look for a mortgage?

PAUL MUOLO: Well, the upshot is, if you have good credit and you can get a loan, you can bottom fish in this market, if you believe that this is the bottom.

For the person with blemished credit, the ballgame is over. It's going to be really hard for you to get a mortgage.

Also, we're going to go back to a system where you have to scrape up and get that down payment money again. No more of this 2 percent, 1 percent down, 0 percent down. Those days are over.

You want to get a house? You'd better, you know, get rid of the big-screen TV, stop going to Vegas, don't eat out five days a week, save your money and get the down payment, and clean up your credit, because the days of easy money are over.

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